Regular Features

Current Regional Banking
Conditions

The Region's commercial banks and thrifts posted their
strongest results in more than a decade at year-end 1997.

Agricultural lending, which is prevalent in almost 60
percent of the Region's banks, may become more volatile as
government payments decline and some export markets react
negatively to the Asian crisis.

Higher risk real estate concentrations in some of the
Region's newly chartered banks warrant attention, especially in
Nevada, where some real estate indicators are showing signs of a
slowdown.

Return on assets (ROA) at the Region's banks and thrifts
mirrored national returns of 1.19 percent for the 12 months ending
December 31, 1997, which is significantly above the 1996 ROA of
0.95 percent. Lower deposit insurance premiums1 coupled
with slightly higher trust fee income and noninterest income from
foreign operations offset a contraction of net interest margins and
a slight uptick in loan loss provision expenses at the Region's
insured institutions.

1 A special assessment on SAIF-assessable deposits,
including those held by Savings Association Insurance Fund members
and Bank Insurance Fund-member Oakar institutions, was imposed in
1996 to capitalize the SAIF at its target Designated Reserve Ratio
of 1.25 percent of insured deposits. The one-time special
assessment of 65.7 basis points was applied against SAIF-assessable
deposits held by institutions as of March 31, 1995, and had a
significant effect on 1996 earnings for institutions that paid the
special assessment.

The ratio of past-due loans (loans past due 30 or more days
plus nonaccrual loans) to total loans at the Region's insured
institutions dropped to 1.97 percent of total loans, well below the
national average of 2.27 percent. The decline reflected improvement
in most loan categories throughout the Region. Consumer loan
portfolios are, however, still showing signs of weakness (see Chart 1). Community banks and thrifts (defined
here as non-credit-card banks and thrifts with total assets of less
than $1 billion) in two of the Region's underperforming
states--Montana and Hawaii--and three
territories--American Samoa, Guam, and Micronesia--did buck the
Region's trend by reporting increases in past-due ratios at
year-end.

Agricultural Lending Is Prevalent throughout the
Region

The health of the agriculture sector significantly influences the
performance of agricultural loans in financial institutions
throughout the Region. Although the Region has only 20 percent of
the total U.S. population, it accounts for over 28 percent of the
nation's agricultural production. California leads the
nation in agricultural production, but Arizona, Hawaii,
Idaho, Oregon, Montana, and Washington also are among
the nation's top ten producers of several agricultural products.

At year-end 1997, banks and thrifts in the Region had $7.4 billion
in outstanding agricultural production loans and another $2.2
billion in loans secured by farm real estate. Almost 60 percent
(461) of the banks in the Region were involved in farm lending, 133
of these 461 banks had over 100 percent of tier 1 capital in
agricultural loans. Of these agricultural or farm banks, 131
can be described as community farm banks, institutions with assets
of less $1 billion dollars.2 The average assets of these
131 community farm banks was just under $100 million. The number of
farm banks in the San Francisco Region declined 23 percent between
1991 and 1997; over half of the reduction occurred in Montana,
where a 1989 change in the state's mergers and acquisition's
banking law spurred merger activity.

2 For this article, the 131 agricultural (or farm) banks
are defined as institutions with total assets under $1 billion
(community banks) and with agricultural loans (agricultural
production loans and real estate loans secured by farm properties)
that constitute over 100 percent of tier 1 capital. Two banks with
over $1 billion in assets also report agricultural loans that
constitute over 100 percent of tier 1 capital, but they are
typically analyzed with comparably larger peers.

Most of the farm community banks are in the northern part of the
Region and in California's Central Valley, as shown in Chart 2. The number of community banks with
agricultural lending concentrations is significant in Montana,
Idaho, and Wyoming, where farm banks account for 56 percent,
44 percent, and 42 percent of total banks in each state,
respectively.

In addition to agricultural lending by community banks with
concentrations in farm lending, four of the nation's top ten
agricultural lenders, ranked by agricultural loans outstanding, are
located in the San Francisco Region. These four large banks have
assets ranging from $8 billion to over $200 billion. They have
multiple branch offices in farming communities, and as a group they
account for over one-half of the Region's agricultural loans. Their
dominance in this market contrasts sharply with the situation
elsewhere in the nation, where the bulk of agricultural loans are
provided mostly through farm community banks, which typically have
average assets of less than $100 million. Two factors that
contribute to the Region's agricultural lending patterns are the
average size of the farms and the value of the products sold per
farm, both of which are about twice the national average. In
Arizona and California, the value of the products sold per farm in
1996 was almost three times the national average. The borrowing
needs of these larger farms can exceed the legal lending limits of
the state's smaller community banks.

1997 Was a Good Year for the Region's Farm Banks

As a group, the Region's farm banks recorded a strong performance
in 1997. ROA for farm banks with less than $1 billion in assets
edged up to 1.24 percent as an increase in overhead expenses was
offset by higher net interest margins. Favorable asset quality also
helped maintain farm bank performance. The past-due ratio (30 days
or more and nonaccrual loans) to total farm real estate loans fell
from 3.01 percent at year-end 1996 to 2.58 percent at year-end 1997
for farm banks with less than $1 billion in assets. The past-due
ratio for loans to finance agricultural production also remained
low for these banks, although the past-due ratio climbed from 0.21
percent at year-end 1996 to 0.39 percent at year-end 1997. Despite
excellent earnings, tier 1 leverage capital ratios at farm
community banks declined from 9.68 percent at year-end 1996 to 9.50
percent of total assets on December 31, 1997, because of strong
asset growth. The loan growth was almost evenly split between
agricultural production loans and real estate loans secured by farm
properties.

Farm Bill and Asian Crisis Mean Challenges Ahead

Notwithstanding the general good health of the farm banks, the
Region's agricultural lenders may face two key challenges in the
coming year. The first is the 1996 Farm Bill. Under this bill,
price supports have been replaced by a series of income payments
that are being phased out over a seven-year period ending in 2002.
Now farmers will base expected crop returns on market prices rather
than on a guaranteed target price, thus exposing agricultural
producers and consequently their lenders to new price risks. The
legislation likely will result in increased price volatility for
commodities because most producers are now free to determine the
type of crop they wish to grow and the amount of acreage they wish
to allocate. The financial transition will be greatest for farmers
with the most dependence on government payments--generally wheat,
cotton, and mixed-grain farmers. In the San Francisco Region,
Montana's farmers may be most affected by the 1996 Farm Bill, as
they are currently the most reliant on government cash payments, as
shown in Table 1.

Montana Farmers
Rely Most on Government Subsidiesfor Their Agricultural Cash
Receipts

AK

AZ

CA

HI

ID

MT

NV

OR

UT

WA

WY

Region

U.S.

Farm Financial
Indicators

Government Payments as
% of Cash Receiptsa

4.1%

2.63%

1.25%

0.12%

3.29%

10.62%

0.90%

2.43%

2.53%

2.67%

3.55%

2.31%

3.48%

Percent of Ag Cash
Receipts from Exportsa

1%

20%

31%

23%

26%

42%

3%

23%

17%

36%

7%

30%

30%

Farm Debt-to-Equity
Ratioa

2.1%

9.1%

23.2%

4.7%

22.4%

14.8%

7.8%

13.7%

9.6%

19.0%

12.8%

na

na

Farm Debt-to-Assets
Ratioa

2.0%

8.3%

18.8%

4.5%

18.3%

12.9%

7.2%

12.0%

8.7%

15.9%

11.4%

na

na

Net Farm Income Change:
'95 to '96a

-7.8%

9.2%

21.9%

-117.6%

27.7%

-18.9%

17.9%

72.4%

19.4%

71.4%

-26.1%

26.4%

42.1%

Percent w/ Farming as
Principal Occupationa

53%

53%

52%

55%

59%

70%

57%

48%

46%

55%

64%

na

na

Statistics on Bank Lending
to Farmers

# of Community Ag
Banksb

0

1

19

0

7

53

0

7

3

19

22

131

2947

Community Ag Banks as a
% of All Banksb

0.0%

2.6%

5.7%

0.0%

43.8%

56.3%

0.0%

17.8%

7.0%

21.0%

42.3%

17.4%

31.8%

Average Community Ag
Bank Size ($ in millions)b

$0.0

$246.7

$214.1

$0.0

$133.9

$48.0

$0.0

$202.1

$43.8

$91.5

$81.1

$98.2

$71.4

Community Ag Banks--Past-
Due Farm Loan Ratiob,c

0.00%

0.00%

0.65%

0.00%

0.26%

1.54%

0.00%

0.12%

1.37%

0.53%

1.64%

0.97%

0.89%

Large Banks--Past-Due
Farm Loans Ratiob,d

4.28%

2.42%

2.35%

14.78%

0.25%

2.00%

0.40%

0.62%

2.97%

0.90%

2.26%

2.69%

1.46%

Ag Loans as % of Tier 1
Capitalb,e

0%

129%

150%

0%

234%

301%

0%

125%

160%

199%

196%

199%

216%

Note: na=not
applicableaSource: U.S. Department of
AgriculturebSource: Bank Call Reports
12/31/97cCommunity Ag Banks are banks with total
assets under $1 billion and all agricultural loans that constitute
over 100 percent of tier 1 capital.dLarge Banks have
assets of $1 billion or more.eAgricultural loans
here are defined to include both agricultural production loans and
loans secured by farm real estate.

The Asian crisis is the second area that warrants additional
monitoring in 1998 for its potential effects on the farm sector.
Agricultural exports nationwide average about 30 percent of farm
cash receipts. In 1997, $24 billion or approximately 41 percent of
the total value of U.S. agricultural exports were shipped to Asia.
The five most troubled Asian economies--Indonesia, Malaysia, the
Philippines, South Korea, and Thailand--account for 12 percent of
U.S. farm exports. Japan and Taiwan, which did not experience sharp
devaluations in 1997, account for an additional 25 percent. The
U.S. Department of Agriculture (USDA) is projecting that U.S.
agricultural exports will fall 2 percent below 1997 levels and more
than 6 percent below 1996 levels because of weaker Asian demand,
increased competition, and lower prices.

Farmers in the San Francisco Region are disproportionately exposed
to the turmoil in Asia for two reasons: First, two of the top ten
agricultural export states in the country--California and
Washington--are in the San Francisco Region; California alone
accounts for more than 20 percent of total U.S. agricultural
exports. Second, a high percentage of the Region's exports go to
Asia. Over half of California's agricultural exports go to Asia,
and selected markets like the state's Central Valley ship as much
as 80 percent of their cattle and cotton production to Asia. Chart 3 summarizes the major commodities in the
Region that are most vulnerable to the projected reduction in
exports to Asia.

Furthermore, world markets affect the value of commodities consumed
domestically. Consequently, some agricultural products that are not
exported directly to Asia nevertheless are being affected by the
financial turmoil. For example, cattle and calves are the leading
products in Wyoming, accounting for 60 percent of the state's
agricultural cash receipts. However, beef exporting countries like
Australia and Canada now are having difficulty selling beef in
Asia, and the strong dollar has made the United States a very
attractive market. While USDA economists believe that Japan will
continue to import two-thirds of all U.S. beef exports, U.S. cattle
production is expected to decline in 1998 because of rising imports
and declining exports. The rising domestic supply may affect the
cash receipts and the health of the ranching industry directly.

Implications: In the coming year, both the 1996 Farm Bill
and the emerging Asian crisis will affect agricultural products and
prices in the San Francisco Region. Although the 1998 price outlook
for major crops and livestock products--for example, beef, cotton,
and wheat--are stable to slightly down, prices could be greatly
undermined if economic conditions in Asia deteriorate any further.
Clearly, conditions in the agricultural sector will affect the
performance of farm lenders as well.

Despite the consolidation that has already occurred in Montana,
farm banks in that state still may have higher than normal risk
exposures. Montana's agricultural sector has a high dependence on
government subsidies, as shown in Table 1. Reductions in those
subsidies will increase the risk agricultural producers face from
changing market conditions and may increase the importance of risk
management for both farmers and farm lenders. This could be
particularly important in Montana, because the farm banks in that
state have an agricultural loan concentration ratio of over 300
percent of capital, the highest in the Region (see Table 1).

USDA can provide additional information on farm sector conditions.
Those interested in topics such as crop prices, stages of planning,
special research papers, and production forecasts may go to the
USDA homepage at http://www.usda.gov/ and the USDA Statistics
Service homepage at http://www.usda.gov/nass/.

Industry Consolidates amid Rising Chartering
Activity

In 1997, the arrival of nationwide interstate banking sparked
merger activity throughout the Region, although many of these
mergers represented consolidations of banks already operated by
large multistate bank holding companies. By year-end 1997, the
number of mergers and consolidations within the Region totaled 80,
well above the 1996 tally of 65. Noteworthy interstate acquisitions
were led by the acquisition of Great Western Bank, which is a
federal savings bank with $42 billion in assets located in
California, by Washington Mutual Savings Bank, which is
headquartered in Seattle, Washington. Many of the 1997
mergers involved affiliated institutions, as large bank holding
companies in the Region took advantage of the new interstate
banking laws to merge some of their out-of-state, and in some cases
out-of-Region, bank subsidiaries into their lead bank. The latter
transactions shifted reported bank assets into the Region. By
contrast, the acquisition of U.S. National Bank of Oregon by an
out-of-Region bank shifted the reporting of over $30 billion in
assets out of the San Francisco Region. More recently, the proposed
interstate merger between BankAmerica, headquartered in San
Francisco, and NationsBank, of Charlotte, North Carolina, would
continue the consolidation trend by creating the largest commercial
bank in the nation.

Industry consolidation and healthy economic growth have been
catalysts for new chartering activity in the San Francisco Region.
In 1994, only two thrift charters and five commercial bank charters
were issued, a record low. The number of insured financial
institution charters tripled in 1995 to 21, edged up to 25 in 1996,
and then accelerated to 37 in 1997. As a result of this increased
chartering activity, financial institutions that are three years
old or less now account for 20 percent or more of the banks and
thrifts in Nevada, Arizona, Idaho, and Utah (see Chart 4).

Newly chartered financial institutions face a variety of
challenges, not the least of which is to establish a profitable,
well-balanced loan portfolio. Loan officers of new institutions,
especially those located in some of the Region's faster growing
states, are facing stiff competition not only from large
well-established institutions, but also from other newly chartered
banks. Because they are located in rapidly expanding markets, some
of these new institutions may develop loan portfolios that are
relatively concentrated in certain types of loans, rather than
being well diversified across a variety of loan types. For example,
as seen in Chart 5, higher risk real estate
loans account for over 33 percent of total assets at Nevada's new
insured institutions, compared with just 19 percent and 11 percent
for the Region and the nation's new institutions, respectively.
This heavy concentration may place these institutions at risk from
the effects of an economic downturn.

Implications: According to the FDIC's History of the
Eighties report on banking problems, " new
banks failed more frequently than existing banks, and banks that
subsequently failed had significantly more of their
assets in higher risk real estate loans." Although the
San Francisco Region continues to enjoy robust economic conditions,
newly chartered institutions, especially fast-growing banks with
concentrations in higher risk real estate loans, may be among those
institutions that are most at risk from the effects of an economic
downturn. Thus, these institutions may warrant close attention from
bank management and regulators.